Last fall it wasn't uncommon to see a 400-point drop in the market in one day. Nor was it uncommon to see highly regarded financial powerhouses -- like Morgan Stanley
Since March 9 we've seen the market climb some 50%, as more cash has been put to work. As the market has surged it has brought those financial stocks that were battered such as Wells Fargo
Given this move, how risk averse are investors right now? Is there still an unprecedented amount of cash on the sidelines? Will the violent volatility we saw last fall resurface? These are the very questions I posed to five experts:
- David Kelly, chief market strategist at JPMorgan Funds.
- John Linehan, co-director of T. Rowe Price's U.S. equity division and portfolio manager of the T. Rowe Price Value Fund.
- Uri Landesman, head of global growth at ING Investment Management
- Bob Doll, vice chairman and global chief investment officer of equities at BlackRock
- Bernie Schaeffer, chairman and CEO of Schaeffer Investment Research.
What follows is an edited transcript of what the experts had to say:
As a measure of risk aversion, there was an enormous amount of cash on the sidelines this winter. How does the money flow compare with the beginning of the year? What are you seeing?
David Kelly: What we're seeing is that people are less risk averse. They are putting money back into both stocks and bonds at this stage. We've seen positive flows into stock mutual funds as well as bond mutual funds.
[Though], we're still seeing more money flow into bond mutual funds [than stock mutual funds]. So, while it's a little bit better, I think people are still very skeptical. They're putting some money into equities as well as fixed income, but in general I think consumer confidence and investor confidence is still very low.
John Linehan: ... it's clear that a lot of people had a fair amount of cash reserves built up. When the economy started to stabilize and the market went higher, it put people in a position where they had a lot of money to put to work, which has driven the market higher. They're far less risk averse since March. I think you see it best in corporate spreads -- Treasuries or in fixed income. Spreads blew out to the widest levels ever and you've seen them come back convincingly in the last several months.
Uri Landesman: I think it's more positive. In the last few months we've seen investors more scared about missing the recovery than about getting in and having the platform blown out from under them like last year.
While there was definitely an unprecedented amount of money on the sidelines, both from retail and institutional investors, I think it's started to flow back into the market. We've gone from a maximum, high-risk averse stance to a much greater appetite for risk. Witness the performance of emerging markets this year, which tend to be the highest-risk equity investments.
That said, no one is 'digging their heels in at the plate.' No one is throwing money in and saying I'm willing to own risk for the next two years. People are dipping in, but they're pretty finicky. I think if they hear there can be a double dip in the recession, or a new area of financial services that has trouble, I think they would become risk averse right away. They've got some risk bets on, but at the first sign of trouble people are going to be quick to take profits.
Bob Doll: Yes. It certainly has improved. Is there as much cash absolutely or relative to the size of the market as there was? No. But is there still a fair amount? Yes.
Bernie Schaeffer: According to data from http://www.ici.org/, institutional money market assets have decreased from $2.5 trillion in mid-January to $2.4 trillion currently...In January 2008, there was only $1.9 trillion in institutional money market funds.
Based on this data, it is our belief that there is still a "risk-aversion" mentality and thus a significant amount of cash among the institutional crowd that can still be deployed into the market.
Are you expecting volatility to pick up in the last months of the year?
Kelly: It might. It has certainly come down a lot since last year, and that's a big positive. If you look at the volatility in the Dow Jones Industrial Average between Sept 15 and Dec 15 last year, those months were the most volatile in the history of the Dow, which goes back to 1896. Volatility has fallen back to more normal levels now.
Though, I think the new normal for volatility will actually be a little higher than the old normal. I wouldn't be surprised to see volatility rise because of some event that we can't forecast. There are plenty of things that can go wrong that could cause volatility to increase as well as push the market down.
Landesman: The CBOE Market Volatility Index (VIX) usually goes up more in down markets ... I actually do not expect the VIX to go up a lot. There are good cases to be made for both the bull and bear sides, and that usually portends high volatility. I'm just betting against it.
Doll: Volatility has slowed from what you and I learned to experience in the last twelve months, but it's still higher than where it was for the majority of most of our careers. I think it's going to stay elevated a bit. Does it increase from what we've seen over the last few months? Not necessarily.
Schaeffer: There is certainly a consensus theme that volatility will move higher, based on the premise that we have "come too far, too fast" in the market and that volatility usually pops in the months of August and September. Because increasing volatility is so widely anticipated, there is less likelihood of actual panic selling that creates a volatility surge.
Professionals have already been buying index puts and VIX calls to hedge or speculate for such an outcome. In other words, some are hedged for a volatility pop and therefore less likely to panic sell. Plus, volatility levels can be viewed as extremely high right now and poised to revert to more normal levels.
For more insight from these experts: